1. General Considerations
a. Government contracts may arise from negotiation or from formal advertising. Contracts resulting from formal advertising must be either firm-fixed-price (FFP) or fixed-price contracts with economic adjustment and interim payments to the contractor, if any, are not based on cost. Audits of contractor billing systems ordinarily do not address policies and procedures for billings on commercial and formally advertised government contracts.
b. Negotiated contracts are grouped into two broad categories: fixed price contracts and cost reimbursement contracts. Fixed price contracts may be firm-fixed-price, fixed-price with economic adjustment or fixed price with incentive provisions. Fixed price contracts may be eligible for progress payments, which are invoiced on SF 1443, 'Contractor's Request for Progress Payment.' Progress payments under fixed price contracts are limited to a predetermined percentage (the 'progress payment percentage' specified in the progress payment clause) of the total contract price and do not include profit. Firm-fixed-price level of effort (FFP/LOE) contracts are classified as fixed price, but the data submitted on billings under such contracts closely resembles that submitted on time-and-materials (T&M) contracts in that profit is included in the direct labor billing rates.
c. Cost-type contracts include cost sharing, cost reimbursement and cost plus fixed fee, award fee or incentive fee contracts. Interim payment requests under cost-type contracts are submitted on SF 1034, 'Public Voucher for Purchases and Services Other Than Personal' and SF 1035, the continuation sheet. Fee may be billed with cost or may be separately vouchered according to the contract terms, and includes a percentage of the fee up to a predetermined limit. T&M and labor hours contracts are also invoiced on SF 1034 and 1035, but profit is included in the price of a labor hour. Contract types are discussed in detail in FAR Part 16. Standard forms are illustrated in FAR Part 53.
2. Special Considerations -- Fixed Price Contracts
a. It is important to review the contract clauses affecting the contractor's right to receive interim payments based on cost. A fixed price contract may require first article approval (FAR 52.209-3 or -4) before the contract is eligible for progress payments. Progress payments must be liquidated against deliveries or other billable milestones under the contract before any amounts other than progress payments may be paid (FAR 52.232-16(b)). The progress payment and liquidation rates are specified on the SF 1443 in items 6a and 6b respectively.
b. The following example will illustrate the computation of allowable interim payments under a fixed price contract which is not in an overrun status. Assume that the contract requires the delivery of 5 widgets over a two-year period at a unit price of $10,000; a total contract value of $50,000 (5 x $10,000); that the liquidation rate is 80% and the progress payment rate is 80%. The contractor invoices the widgets as they are delivered. There is no standard form for invoicing deliveries. If at the time the first article is delivered the contractor has incurred $12,000 of eligible progress payment costs and invoiced them on SF 1443s, it will have received $9,600 (80% x $12,000) of unliquidated progress payments. The government liquidates $8,000 (80% x $10,000) of this against the first article, leaving an unliquidated balance of $1,600. The contractor will bill the government and receive a payment of $2,000 ($10,000 -- $8,000).
c. The contractor is required to report an estimate to complete on SF 1443, item 12b. The instructions to SF 1443 require that this estimate shall be made not less frequently than every six months. FAR 32.503-6(g) requires that if the estimated costs are likely to exceed the contract price, the contracting officer shall calculate a loss ratio factor and adjust future progress payments to exclude the element of loss. Audit steps for evaluation of the contractor's estimate to complete and a matrix for computation of the loss ratio factor appear in the standard audit program for progress payment audits.
d. In addition to verifying that billed costs include only amounts properly recorded and, where required, paid in accordance with an approved cost accounting system, a billing system survey at a location having significant progress payment billings must include a review of the policies, procedures and controls for:
(1) Identifying requisite billing data (progress payment and liquidation percentages, first article approval, billing frequency, etc.).
(2) Assuring compliance with contractual billing conditions.
(3) Preparing and updating estimates to complete.
(4) Timely computation of loss ratio and progress payment reduction when appropriate.
3. Special Considerations -- Flexible Fixed Price and Fixed Price-Level of Effort Contracts
As with FFP contracts, progress payments under fixed price incentive (FPI) contracts are made in accordance with FAR 52.232-16. From an interim billing standpoint, FPI contracts differ from FFP only in the profit computation. They must be audited prior to final payment because the incentive profit is based on a comparison of the actual to the target cost. In an FFP/LOE contract, the deliverable product is the labor hour. Accordingly, such contracts rarely provide for progress payments based on cost. In reviewing billing systems at contractor locations having a significant volume of FFP/LOE work, treat these contracts as if they were T&M.
4. Special Considerations -- Cost-type Contracts
a. Because the government assumes a higher percentage of risk under cost reimbursement type contracts and because such contracts may contain any number of special provisions affecting billings (ceiling rates, unallowable or unallocable cost elements, key personnel, fee billing and retention, etc.), the accounting and billing system requirements for such contracts are more stringent than for FFP and FPI contracts. Cost-type contracts permit inclusion in the periodic billing of all allowable and allocable paid costs and certain recorded but unpaid costs which do not exceed the contract ceiling or funding limitation, reduced by the contractor's percentage in the case of a cost-sharing contract; and such costs are provisionally reimbursed in full, subject to subsequent audit. Fee billings may be vouchered with cost or separately, depending on the contract terms which frequently provide for a fee retention pending contract completion and closeout.
b. In addition to verifying that billed costs include only amounts properly recorded and, where required, paid in accordance with an approved cost accounting system, a billing system survey at a location having significant cost-reimbursable work must include a review of the policies, procedures and controls for:
(1) Identifying requisite billing data (type of fee, billing procedures, including required supplemental data, frequency etc.).
(2) Assuring that appropriate controls for briefing contracts and adhering to contract provisions and contract ceilings are in place and functional.
(3) Monitoring progress under the contract to provide the data required by FAR 52.232-20b (the Limitation of Cost clause).
(4) Promptly adjusting indirect billing rates for revised budgetary data.
(5) Where applicable, promptly adjusting prior billings to reflect final rates and direct cost disallowances.
(6) Including Form 1 suspensions on subsequent vouchers as an offset to cumulative billed cost.
5. Special Considerations -- T&M and Labor Hours Contracts
a. T&M and labor hours contract costs are vouchered on SFs 1034 and 1035. They are a mixed contract type, since labor is billed at price and other direct costs (ODCs) are billed at cost. T&M and labor hours contracts provide for billing direct labor hours at predetermined category rates which include all applicable burden and profit, and bill ODCs (and direct materials on T&M contracts) at cost plus applicable burden. These contracts permit billings up to a stated percentage of the contract value, and may or may not require that each invoice be adjusted to the limitation percentage.
b. T&M and labor hours contracts contain an inherent risk so high that they may be used only after the contracting officer executes a determination that no other contract type is suitable. Nevertheless, at many locations this least favored contract type constitutes a substantial percentage of the workload. A billing system audit is not the best place to identify and correct control weaknesses which arise under this contract type. Refer to 6-204.
c. It is quite common for the contract to specify labor categories which do not coincide with the contractor's established labor classifications. Ideally, the contract itself will specify the required skills and experience for each billable labor category. When this is not the case, the contractor's proposed classifications determine the propriety of employee classifications to contract categories by operation of the Order of Precedence clause (FAR 52.215-8). The contractor's labor distribution system should input incurred labor hours by contract category to the billing system, and the controls preventing misclassification of employees should be reviewed as a part of the labor controls. If these controls do not exist, or have not been evaluated, they must be evaluated as a part of the billing system audit.
d. In addition to review of the controls affecting cost-reimbursable billings, review of a billing system which processes a significant volume of T&M, labor hour, or FFP/LOE contracts must verify that controls are in place which assure: that billings include only actual labor hours per the labor distribution; that each billed hour is assigned to its proper category; and that categories are billed at the correct contractual rate.

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